TMFDeej (99.21)

Harvard & Princeton Professors Bash P-PIMP Plan

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Two well-known ivy league professors, Harvard's Joshua Coval and Erik Stafford and Princeton's Jakub Jurek, published a report yesterday stating that they believe the whole premise behind the government's toxic asset auction program, which I affectionately refer to as P-PIMP, is wrong.

Coval and Stafford believe that the government's view that the toxic assets on banks' balance sheets are bring improperly priced because of a lack of liquidity in the markets and forced fire sales is incorrect. Instead, the two contend that the low prices that are being offered for these "toxic assets" reflect their actual fundamental value.

They believe that the mis-pricing of these assets happened before the current economic meltdown, in essence that they were priced to high to begin with and that their current market value is closer to their real worth than the prices that we saw in 2007 and earlier. I have to admit that my own experience lends me to believe that there is a lot of merit to this line of thought. The lack of risk aversion and the massive amount of the liquidity in the bond market forced me to stop buying corporate bonds for a number of years because the yields that were available were not in line with the risk that one would have to assume. Today, corporate bond spreads are much more reasonable and I have returned to the market.

Many famous economists believe that the while the government thinks that the current crisis is a liquidity problem, but it is actually a solvency problem.

Highlights of the aforementioned report include the following:

"...many major US banks are now legitimately insolvent. This insolvency can no longer be viewed as an artifact of bank assets being marked to artificially depressed prices coming out of an illiquid market. It means that bank assets are being fairly priced at valuations that sum to less than bank liabilities."

and

"...any taxpayer dollars allocated to supporting these markets will simply transfer wealth to the current owners of these securities."

and

"...policies that attempt to prevent a widespread mark-down in the value of credit-sensitive assets are likely to only delay – and perhaps even worsen – the day of reckoning."

Basically the duo conclude that the government cannot save the banks by changing the mark to market rules or by flooding the market with liquidity. They believe that the crux of the problem is that extremely leveraged companies bought a ton of assets that are worth a lot less than they thought they would be and as a result they are now insolvent.

If this is the case, and as sad as it makes me to day this the theory makes a lot of sense, all of the billions and billions in bailouts that Uncle Sam is throwing at banks and other companies is nothing more than a transfer of wealth from American taxpayers to public and private companies.